The Power of Compound Interest

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You've probably heard of the age-old advice about the importance of saving for retirement and the wisdom of starting early. But why is the timing of your savings more critical than the amount you save? The answer lies in a simple yet powerful concept: compound interest.

Compound interest is the secret that makes your money work harder for you. Unlike simple interest, which accrues solely based on your initial deposit or principal amount, compound interest allows your investments to grow exponentially by earning interest on both the principal and any accumulated interest.

Compound Interest vs. Simple Interest

Let's break it down further. With simple interest, your earnings remain constant because interest is calculated solely on the principal amount. However, compound interest, your returns snowball over time as interest is continuously added to the principal, creating a compounding effect that accelerates your wealth accumulation.

What Makes Compound Interest Powerful

Compounding is special in the way that it works over a period of time. If you were to not contribute any additional funds to your initial investment, compound interest would ensure that your money continues to grow. No matter the size of your savings, your funds will benefit from compounding. The longer you keep funds invested, the more time your money can work for you by earning additional interest.

Let's take a look at the graph below. In this example, all participants are investing $5,000 annually at a 7% interest rate.
As shown in the graph above, everyone started with an initial investment of $5,000 and continued to invest the same $5,000 annually at the same rate of 7%. Jordan chose to invest over the course of 40 years and has a savings balance of $1,142,811 ($942,811 earned in interest), whereas Chelsea invested for 10 years and has a savings balance of $69,081 ($19,081 earned in interest). This is a great visual to articulate that it is not how much you are placing aside, but more so the length of time you are willing to invest your funds.

Understanding the "Rule of 72"

Now, how can you estimate when your investment will double? Enter the Rule of 72, a formula to determine the approximate time it takes for your investment to double in value. The formula for the rule is: Number of years to double an investment = 72/Interest Rate

For instance, let's say you have an investment with an annual interest rate of 7%. Using the Rule of 72, you would calculate 72 divided by 7, which equals approximately 10.28 years. So, in just over a decade, your initial investment would double in value.

It's crucial to recognize that while the Rule of 72 provides a useful estimate, it doesn't account for additional contributions over time. Continuing to invest regularly can significantly accelerate your wealth accumulation and enhance your financial security.


Ready to Start Saving or Investing?

Understanding ways to capitalize your hard-earned funds can unlock your potential to live a more financially stable life. Although it is better to start early, it is never too late to start saving. Consider contacting Michigan First Credit Union for your savings and retirement options!

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